5-2: What Are the Costs of Production?

1. 5-2: What Are the Costs of Production? Chapter 5: Supply

2. How Labor Affects Production • Sarah owns a small factory that produces custom blue jeans. Currently, there are 3 employees who can collectively produce 12 pairs of jeans per day. If Sarah hired one additional worker, how would that affect production?

3. Marginal Product • To answer that, we look at marginal product: thechange in total output by adding one more worker

4. Marginal Product (continued) • We see that with 4 workers, Sarah’s factory can produce 19 pairs of jeans each day— that is a marginal product of 7 pairs of jeans • With a 5th worker output is 29 pairs of jeans, with a marginal product of 10

5. Marginal Product Schedule • This shows the relationship between labor and marginal product

6. Sample Marginal Product Schedule

7. What can we learn from the marginal product schedule? • Specialization increases marginal product • At some point, total output still increases but marginal product begins to decrease

8. Increasing Returns • Definition: when hiring new workers causes the marginal product to increase

9. Diminishing Returns • Definition: when hiring new workers causes marginal product to decrease • Looking at the marginal product schedule it can be seen there is a point when hiring more workers is counterproductive

10. Production Costs • The goal of business is to earn as much profit as possible • There are several different kids of costs

11. Fixed Costs • Definition: costs the business owner incurs no matter how much they produce • Examples: mortgage, insurance, and utilities

12. Variable Costs • Definition: costs that vary based on the level of production output • Example: wages

13. Total Cost • Definition: the sum of fixed and variable costs

14. Production Costs Schedule

15. Calculating Marginal Cost • MC=change in total cost / change in total product • For example: based on TC for 4 workers and 3 workers: • TC: 172-137 =35 • TP: 19-12=7 • MC: 35/7 =5

16. Earning the Highest Profit • Marginal Revenue: money made from the sale of each additional unit of output • MR= price of the good being sold

17. Earning the Highest Profit (continued) • Total revenue: income a business receives from selling its products • TR= P x Q • (Where P=price of product and Q=quantity purchased at that price)

18. Production Costs and Revenues Schedule

19. How to Calculate the Production Costs and Revenues Schedule • TR= MR x Total Product • Profit=TR—TC • The point on the chart where MC=MR • On our schedule this would be when 9 workers are producing 66 pairs of jeans

20. Profit-maximizing Output • Definition: the level of production at which a business realizes the greatest amount of profits • Simply put this is where MC=MR

21. Questions & Problems • 1. How does a business use marginal analysis to decide how many workers to employ?

22. 2. Categorize the following costs incurred by a bookstore owner as fixed or variable: • Accountant • Electricity • Wages • Insurance for workers • Manager’s salary • Purchase of books • Rent • Phone

23. 3. Suppose that a video store has total costs of $3,600 per month. If you charge $12 per DVD, how many DVDs need to be sold each month in order to break even? • 4. Then, explain how you arrived at this answer.

24. 5. The owner of a factory that produces soccer balls determines that his marginal product is at its peak when he has 100 employees. He determines that his marginal cost and marginal revenue are equal when he has 150 employees. What number of employees should he hire in order to maximize his profit? Then, explain the reason for your answer.